Opinion: Long term debt is not our friend

Wayne MerrittBusiness consultant

Published 8:40 am, Monday, April 14, 2014

How much debt is too much for Midland? I wish the answer was easy, but it isn’t. Each community has unique financial needs and cultural characteristics that determine its appropriate level of debt. Over the next few years, the answer will require all the business judgement our community can muster. As a banker for 34 years, my short answer is: Choose priorities carefully, fund them well and pay off the debt as soon as possible.

Midland currently is enjoying a phenomenal economic expansion. From 2010 through 2013, the taxable property value in Midland County increased from $13.5 billion to $20.3 billion, amounting to almost $150 million per month. 2013 alone averaged valuation growth of $220 million per month. The growth rate of virtually all economic indicators remains well above our economic trend line.

The main consequence of Midland’s frantic economic pace and population explosion is an infrastructure under significant stress. The water supply crisis cost about $225 million, but thankfully we now have a reliable water supply. Midland College needed ($45 million) and the hospital expansion ($115 million) were addressed none too soon. The county will need considerable money for roads and the city must provide essential services to keep up with housing and commercial property growth.

A looming financial decision is MISD. In November 2012, voters approved a $163 million bond issue. However, MISD’s expressed needs over two years ago were estimated to cost $500 million. It is likely those remaining needs have grown rather than diminished. It is our duty, and it will cost significant money, to create a high performing public school system.

There are two steps I think would clarify the appropriate amount of debt for our community. We need an annual presentation of a consolidated community financial statement reflecting all of the taxing entities. Currently, each taxing entity is statutorily independent, so the taxing entities work together informally to queue their bond elections. Taxpayers have to consider each bond proposal separately rather than knowing, or at least connecting, the bottom line for all of the entities. The global presentation should include a forecast of expected or potential issues that may require bond proposals as well as revenue forecasts and an economic outlook. The immediate future holds debt and investment decisions that are community makers. Voters need to see the consolidated existing plus future debt in the context of Midland’s much larger tax base to handle debt levels we’ve never seen before.

The above described presentation will also serve as a “stress test.” It is standard practice for banks that lend money against oil and gas properties to assess the value of their collateral at lower product prices. Because Midland’s economy is dominated by the energy business, I think it is a fair analogy to assess on the front end our ability to service new debt comfortably at a “base case” for energy prices. Yes, a base case is subjective, but everyone in the business has one.

Secondly, I hope the recent bond to fund the new hospital will be a model for the future. The budget for the new tower and improvements was about $175 million, but the final bond debt was $115 million because $60 million was contributed by individuals and foundations. This process allows Midlanders to express not only their generosity but also their appreciation for a community that has served them well. From a financial standpoint, the interest saved on the $60 million private investment will be about $45 million.

Please look closer at the hospital debt. Without the $60 million in private contributions, the hospital would cost $306 million: $175 million in principal and $131 million in interest. If the $115 million bond debt had been financed over 20 years rather than 30, taxpayers would have saved an additional $32 million. Finally, financing the $115 million over 15 years would require about $2 million per year additional principal (yes, more taxes) but would save additional $14 million in interest, resulting in a total 15 year cost of $155 million — about half price.

How much debt we actually have is defined by the repayment schedule. For example, the $175 million hospital financed over 30 years is the same dollar total as $266 million in principal debt with a 15-year amortization. The takeaway here is that additional legitimate needs can be met if we forego the 30-year bond in favor of 15-20 years. Debt that hangs around too long is not our friend.

Despite past generosities, no citizen/philanthropist is “obligated” in any way to support any bond proposal. Like the hospital bond, the proponents must present a convincing request. In the event smaller private contributions are offered, it becomes even more important to pay the debt within 15-20 years at most.

My main point is that when the priorities have been determined, clear and consolidated financial information, private contributions and rapid repayment of debt are the best ways to reduce our financial risk.

Midland is truly blessed to have huge investments by world-class companies: Concho, Chevron, EOG, Pioneer, Fasken and others are building facilities that indicate a commitment to the long term. Yes, those investors expect the lowest property and mineral taxes possible, but they also expect Midland to be a quality community — as do we all.